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Dorgan, Cantwell say high oil prices may reflect rampant speculation

Two Senate Energy and Natural Resources Committee members said on Apr. 3 that they will push for more aggressive financial market regulation if they don't get a better idea of speculators' impacts on crude oil prices.

Democrats Byron L. Dorgan (N.D.) and Maria Cantwell (Wash.) each said that the Commodity Futures Trading Commission's oversight still does not include transactions which occur outside regulated commodity exchanges. Deals for oil as an investment may be distorting its actual value and aggravating economic uncertainty, they warned.

"These energy prices are having enormous consequences. We have people buying what they'll never get from people who never had it. Twenty times more oil is sold in these markets than exists," Dorgan said.

When Cantwell asked three energy analysts who testified if they predicted a year ago that oil prices would exceed $100/bbl, they all said they did not and declined to forecast where prices would be six months from now. "You're basically saying this is all over the map and you don't know what the price will be. If we're going to protect our economy, we need to close loopholes that keep this activity in the dark," she said.

Speaking with reporters outside the hearing, the senators separately said that they will try to increase regulatory authority and funding at the CFTC, Federal Trade Commission and Securities and Exchange Commission as part of the three agencies' fiscal 2009 appropriations.

"Where were the regulators? Who was minding the store? This is something that has occurred throughout this administration. The chairman of the SEC promised a business-friendly environment when he took office. What kind of a signal did that send?" Dorgan said.

Growing participation

Other committee members agreed that growing participation by traders seeking oil purely as a financial asset requires more attention but stopped short of calling for increased regulation. Chairman Jeff Bingaman (D-N.M.) noted in his opening statement that the Government Accountability Office reported last fall that the average daily contract volume for crude oil traded on the New York Mercantile Exchange increased by 90% between 2001 and 2006. It also noted that the average daily number of non-commercial participants in crude oil markets, including hedge funds and large institutional investors, more than doubled from 2003 to 2006, he said.

"It seems that just as the demand for physical barrels of oil has grown with the global economy, there is an increasing demand for oil purely as a financial asset," Bingaman suggested.

"Untangling whether and how these dual sources of demand may be operating in concert and potentially impacting oil prices is complicated. But, certainly, I think it's accurate to say that there is a growing suspicion on the part of many Americans that, in the very least, Wall Street's geopolitical judgments may be serving to increase current pricing trends," he continued.

Sen. John Barrasso (R-Wyo.) noted that factors ranging from growing demand and declining excess supply capacity to the US dollar's falling value and increased reliance on politically unstable and sometimes unfriendly foreign suppliers are pushing oil prices higher. Adding that domestic production must expand, he asked if more regulation would lead to America's losing its leadership in financial markets.

Pete V. Domenici (R-N.M.), the committee's ranking minority member, noted that Rep. John B. Larson (D-Conn.) plans to introduce a bill which would require investors to take delivery of crude oil and petroleum products. Doing this would eliminate speculators who driving prices higher from oil and gas markets, Larson said in Hartford on Mar. 31 as he announced his plan. He plans to introduce the legislation soon, a spokeswoman told OGJ on Apr. 4.

"For me, after today's testimony, I wonder whether we haven't made a mistake in not trying to regulate speculators on the oil market more closely," Domenici said during the hearing.

Proposal's impacts

But Jeffrey Harris, the CFTC's chief economist, warned that Larson's approach would remove from the market an entire class of investors who take positions that others won't take. "I don't think trying to identify speculation's part of today's oil price constructively moves the discussion forward," added another witness, Sarah A. Emerson, managing director of Energy Security Analysis Inc. in Wakefield, Mass.

"There's a difference between speculation and the casino example used earlier," she told the committee. Institutions such as the California Public Employees Retirement System (CalPERS), the largest US public pension fund, buy oil derivatives to add value to their portfolios, Emerson said. "These are not gamblers," she maintained.

A third witness, Cambridge Energy Research Associates Managing Director James Burkhard, also said that non-commercial investors are not simply short-term speculators but include pension fund, university endowment and other institutions' financial managers. They also help keep markets liquid, he indicated.

"The growing role of non-commercial investors can accentuate a given price trend, but the primary reasons for rising oil prices in recent years are rooted in the fundamentals of demand and supply, geopolitical risks and rising industry costs. The decline in the value of the dollar has also played a role, particularly since the credit crisis first erupted last summer when energy and other commodities became caught up in the upheaval of the global economy," Burkhard said.

As lower interest rates and anticipation of further cuts pushed the dollar lower, oil became what he called the "new gold," a financial asset in which investors seek refuge as inflation rises and the dollar's value weakened. "Today's dynamics in the marketplace reveal oil's increasingly cosmopolitan nature. Its price reflects not only demand and supply, but broader macroeconomic and geopolitical changes such as the growing influence of Asia, the Middle East, Russia and the Caspian countries," he said in his written testimony.

Won't last forever

Kevin Book, senior vice president of FBR Capital Markets Corp. in Arlington, Va., said that it may be true that non-commercial buyers of oil forward and futures contracts may be helping drive the price higher because institutional investors are seeking a value-retaining refuge from the falling dollar, "this phenomenon certainly won't be true forever and may not even be true for long."

"If funds flowing into commodities are indeed elevating oil futures, then accumulating evidence of a slowdown within the world's biggest oil consuming economies could provoke an equal and opposite reaction as conservative investors close their positions and aggressive investors sell short," Book said.

He and other witnesses noted that sovereign funds, which invest oil producing countries' revenues, are a growing non-commercial oil futures class. Harris said that the CFTC is aware of this group's activities but does not have extensive data on it. He also confirmed that the agency's staffing is at a historic low at a time when futures and derivatives trading are at a historic peak. "We can see what's happening in markets we don't regulate by the behavior of large traders and other reports we receive," he said.

Emerson pointed out that national oil companies in producing nations are currently making a lot of money and investing a lot of it in new capacity, which is good. Asked by Bingaman about steps the United States could take, she replied, "There's no quick fix. I think the margin requirements need to be raised for oil futures trading. It's one tool Congress can use." Other witnesses agreed.

Burkhard said that oil prices in the $110-120/bbl range over six months would reduce demand even in China, India and other economically growing nations. "It can't keep climbing and there will be some relief. But it's important to remember that an entire generation of employees didn't enter the oil industry in the 1980s and '90s because the price was so low. It could take 10-15 years to recover from this," he said.

Dorgan remained skeptical. "You'd have to be drunk to not understand that when you run an $800 billion trade deficit, it won't have an impact on the value of the dollar," he conceded. "But there also are speculators involved."

Contact Nick Snow at nicks@pennwell.com


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